The Fed's Tom Barkin On the Impact of Higher Interest Rates

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1:22Hello and welcome to another episode of the Odd Thoughts podcast. I'm Traci Alloway. Joe is sick today, and so I am very pleased to say that I have a guest co-host, Matt Bosler. He is an economics editor for Bloomberg. Hi, everyone. I'm Matt Bosler. Excited to be here. So, Matt, I'm so glad you're doing the show today. It is an interesting time in the U.S. economy, and particularly this week. We're recording on September 28th. We've just seen this massive sell-off in the bond market following the recent FOMC meeting. There's lots of talk about higher rates for longer, lots of concerns over whether or not inflation is maybe picking up again, given the rise that we've had in the oil price recently.

2:05But overall, it kind of feels surprising how resilient the U.S. economy has so far proven to higher interest rates. Yeah, it's really interesting. You know, the Fed has been raising its benchmark short-term interest rate for 18 months now. we haven't really seen an aggressive move up in long-term interest rates until just the last several weeks. So it's almost like the tightening cycle. Maybe it's just gotten started here. Right. 30-year yield, I think when I last looked at 4.7%, something like that. You also have all these headline risks sort of lurking. There is the looming government shutdown that might actually have started by the time we release this episode.

2:45There's questions over the UAW strike. All these sorts of idiosyncratic risks also starting to come into play. And here on Odd Lots, I think people know that we always like to try to tie the macroeconomic outlook and monetary policy to the real business stuff that's happening on the ground. So I am very pleased to say that we do, in fact, have the perfect guest with us today to discuss all that. We're going to be speaking with Tom Barkin, the president of the Richmond Fed. Tom, thank you so much for joining Odd Lots. I'm looking forward to it. And you certainly laid out a long list of things we need to cover.

3:19I know. And we only have about 40 minutes, but we'll try to do our best. Maybe just to begin with, I know you have taken a kind of, I don't want to say unusual approach, but maybe a special approach to your job as president of the Richmond Fed. you like to go out and talk to businesses within your region. And I'm curious, I know that you were previously at McKinsey, but how does that kind of feed into your thinking around monetary policy? What do you get out of those discussions? So we have a beautiful 24-story building in Richmond. If you drive down I-95, you'll see it. It's quite literally an ivory tower.

4:03And so one thing I figured out pretty early in my tenure was that the data comes in late. It's then revised three times. And so it's awfully hard to know what's actually going on. And so I just made a personal commitment that with the exception of the two weeks around the FOMC meeting, I'm going to be out every week. And in the last month, I've been on the Eastern Shore. I've been in the coal country in South Carolina. I've been in Southern Virginia. I've been in the Northern Virginia suburbs. I've been in Western Virginia. And in every one of those trips, I'm meeting with business people. I'm meeting with nonprofits.

4:33I'm trying to understand what's actually happening in the economy. And that's where I get my information to sanity check the data as it's coming in and try to develop my own unique perspective on what's happening. I think to my knowledge, you're the only Fed president who has actually mentioned the Beyonce and the Taylor Swift concerts in a speech, a formal speech. I don't know if that's true, but my daughter also wanted me to put in a few quotes from the Barbie movie, and I managed to withstand doing that. You know, we have so many people here in New York in this building and in the surrounding area, right, just pouring over every monthly economic statistic, whether it's the jobs report, the inflation report.

5:12When you're going out to all of these places, are you hearing things from businesses that are not necessarily being reflected in the data right now? Yeah. So a couple of great examples. Demand. If you look at the recent data we've gotten on consumer spending, it's been unbelievably resilient, as you said. up front. When you talk to businesses, you'll hear it's okay, right? That's a pretty big gap. And I was with a big retailer about three weeks ago that started talking about what they perceive to be the different segments of consumer spending, the high-end consumer who's still spending on experiences like Taylor Swift and Beyonce.

5:51There you go. I got it in there again. Versus the low income consumer who we all know savings been somewhat depleted. And he started talking about the middle-income consumer. And the way he described it was, they're trading down. They're going to the grocery store, the branded grocery store for their food, but they're buying the kids' notebooks at a dollar store. And you hear those sorts of things, and then you try to find the evidence in the data to talk about what's happening. On the labor side, I was with a manufacturer in South Carolina who said that they're losing people to Bojangles, which was an awfully strange idea.

6:28For those of you who don't know, Bojangles is a fried chicken place largely in my district in the South. But it turns out it's an indoor environment, not an outdoor environment. Shift flexibility is obtainable, so you can work the hours you want to work. And the pay of Bojangles has actually narrowed most of the gap with the manufacturer. Then two weeks later, I told you I was in coal country. I was talking to a guy who owns a coal mine, and he was describing his problems getting workers. And I said, wait a second. This is West Virginia, there's all these stories of the coal mines not being able to operate enough and all these unemployed workers.

6:58He said, yeah, but the thing you have to understand is that cell phones don't work inside a mine. And people don't want to work if they can't bring their cell phone to work. And so I've been, you know, you asked what's different from the data. The data would suggest to you that the labor market has settled. But what I'm hearing is that the labor market, which was very stable for a long time, and the hierarchy of jobs has gotten thrown up in the air. And there's a set of jobs that used to be paid X and are now paid Y, where they're more advantaged and other people are being left behind. Think state and local governments that can't increase their pay.

7:33There are other jobs that offer remote work versus or cell phone access in your workplace and others don't. And those are getting ahead. And so employers are struggling to catch up with the new hierarchy of jobs. And if you're in one of those jobs, think childcare or teachers or state and local government or nonprofits, those folks still have more to do to get their jobs filled, to get people into jobs, to retain people. And there's wage inflation potentially related to that. So that's the kind of thing I'm trying to pick up when I'm out there. And I think it helps make me think about the economy in a totally different way than just what the data shows.

8:10That's so interesting because, of course, when you look at the data, it's all aggregated. So you can't see those types of qualitative annotative variations that you just described. Just on the notion of companies, some companies may be still struggling to find workers. You had a really good speech, I thought, back in August, where you basically argued that one of the big reasons we haven't seen a recession in the U.S. yet is that memories of the pandemic are still very fresh. And so companies are still reacting to past shortages, as opposed to really worrying about excess capacity. Do you think that dynamic starts to change as interest rates go higher.

8:49And what I mean by that is at some point, does the added expense of investment at higher rates kind of start to outweigh concerns over future capacity? May I say two things I was getting at in that speech. One of them is that if you just spent a year trying desperately to fill empty jobs, you're going to be a little cautious before laying people off cavalierly. And I think if you look at the layoff announcements by businesses over the first half of the year, for example, you'll see they're massively disproportionately professionals, not frontline workers, not skilled trades and manufacturing construction workers.

9:24And I think that's because people genuinely are concerned they won't be able to find those people if they lay them off. The other thing I was getting at there is we've been predicting this recession for a long time. It's been 16, 17 months where the leading economic indicators have all been pointing to recession. If you're a business, and I've talked to a bunch of businesses about this, last year's plan, they scaled back. This year's plan, in other words, the 2024 plan, they're scaling back. So they're being cautious. They're not investing in discretionary spending. They're making those kind of investments.

9:57And so if you do have a downturn, the implications are just going to be much less because people have already prepared for it. When it comes to the question of business investment, businesses, interest rates, and how they affect it, I saw a great chart last week that was interest expense as a percent of revenue for American corporates. And what it showed is - Still pretty low, I think. It's now basically exactly where it was in 2019. That doesn't mean there's some people who aren't paying a lot more, but on average, a lot of people refinanced during the COVID era. A lot of people aren't as dependent on borrowing.

10:33And so in total, people aren't paying more in interest. Corporations aren't paying more in interest right now. Not yet. I mean, presumably that'll come. Just on that note, I'd be curious to hear what you have to say about the impact of higher rates in general and where you see the effects of the recent tightening the most in terms of the real economy. So for instance, it sounds like it's not having that much of an impact on investment for the reasons that you just laid out, but is it having a noticeable effect on, for instance, consumption? Well, so the place you can see it most clearly is what I'll call interest-sensitive sectors.

11:09Housing, obviously, was very frothy when we started our interest rate increases. It's gotten less frothy. Automobiles, durables, furniture, all those sorts of things. Banking, you obviously have seen the impact so far. On the consumer side, you'd expect to see, and I would have expected to see more impact than we've seen to date. I have to say there's still a lot of the pandemic in the economy. And what I mean by that is the excess savings that came through for people not spending as much or retaining whatever stimulus. Another interesting thing I ran into the other day is that adjustable rate mortgages, which back in the 2000 era were a very large part of the mortgage base.

11:52Right. Option, Armageddon, and all of that. Exactly. In 2003, are 8 % of all mortgages. And so whereas you might have thought that interest rates would reset very quickly, they actually haven't reset all that quickly. Commercial real estate is a place you clearly see at another interest-sensitive sector. So we see it in interest-sensitive sectors. Business investment is flattened, is how I'd put it. consumption still remains very healthy. But I still think there's impact of the rates in train. I still think it's coming in train. But I'd agree it hasn't been nearly as impactful as you would have imagined when we started increasing rates a year and a half ago.

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14:25You mentioned housing, and I mean, I think that's a really interesting example to look at here, because we usually think about that as the sector that is traditionally most linked to monetary policy. And of course, it's also historically played such an important role in the U.S. business cycle overall, right? But we're in a situation here with housing now where mortgage rates have shot up. People are not moving. So you're seeing that impact on kind of sales and construction. And yet house prices are already back at record highs. So how do you assess the impact that you're having in a situation like that where activity has fallen off a lot, but you're not really seeing any sort of follow through at the price level, which is perhaps one might think what Fed officials care most about?

15:11Well, so let me just talk for 10 seconds about housing before getting to your question, which is, I just think there's been a secular change in the priority people place on housing in their wallet. If you're spending five days a week at home, three days a week at home, seven days a week at home, your house matters a lot more, your office matters more, your patio matters more, your furniture matters more. And we saw that during COVID. And so I just think people are much more focused on their house than they were before. And that has created a demand increase. In addition, you had a generation of millennials who are now having kids and thinking, I kind of need a house, and that has also been a demand increase, and a generation of seniors who think that nursing homes aren't quite as attractive as they were before COVID, and that's had a supply decrease.

16:00We increase interest rates. I do think that has brought demand down. I mean, when you hear from home builders and others who are selling houses, demand for houses has clearly moderated from the frothy 12 offers for every house at$20 ,000 over list that we had about a year and a half ago. That said, the supply is still short. And it's short for the obvious reason that if you have a 3 % mortgage, you're not dying to sell that house and get into a 7 % mortgage. It just changes the financial formula. And so what we see in terms of the effect is you still very limited supply of houses for sale. Residential construction, which you said is cyclical and normally is, it's actually not as weak as you'd think it would be because the big home builders are saying, I can sell every house I can make.

16:45And so they're building houses, right? That 10 % of the market is actually pretty vibrant because people still need houses. They can't find them. And so they're buying new houses as opposed to existing houses. But the existing house market is, I'll say the supply is very weak. The demand is coming off, but it's still in excess of supply. And that's what's keeping the prices high. How do we look at impact? I mean, we have one tool called interest rates. It's a pretty blunt tool. When I talk to home builders and realtors, I'm asking questions, is demand coming off or not? It is quite clear that demand's coming off.

17:20It's quite clear there are fewer bids per house. When is price coming down? That's a much more difficult thing to get to. And it's definitely stabilized from the extreme spikes we were seeing a year and a half ago, but it certainly hasn't come down in any kind of scale. So two quick follow-ups then. Is the upshot basically that perhaps the most you can hope for here in this kind of supply constrained environment is just that you are going to slow the rate of growth of price increases? And then also, does that kind of then change the way you think about the monetary policy transmission mechanism in that maybe you have to lean harder on other sectors of the economy to get the overall type of slowdown that you're trying to achieve with higher interest rates if housing is not going to play a central role to the whole story?

18:07Yeah, because this is also slightly different to what Powell said, I think, like a year or maybe two years ago, where he was talking about the need to put some sort of dampening pressure on house prices. Here's how I'd think about it. To bring pricing into alignment, you want supply and demand to get into better balance. That means both the supply side and the demand side matter. We are seeing progress on the supply side. A lot of the supply chain issues we had a year or two ago, with the exception of chips and switch gears, seem to be in much better shape. You've seen labor force returning to the market at much higher levels.

18:41So you're getting some help on the supply side. And we're doing what we do on the demand side, right? And we're just trying to calibrate that. And so to get to where you need to get into balance, you can get there with lots of different goods and services pricing in very different ways. You don't just have to get one element in shape. Now, housing is a big part of the economy. And so if rents come into line and housing comes into line, that would be useful. But relative prices move all the time. And if what we've had is a secular shift toward more demand for housing, that might mean, somewhat less lessening of housing prices and somewhat more lessening of another set of prices.

19:17Can I ask more generally how you're thinking about, you know, if we assume that a lot of the recent inflation has been driven on the supply side, and, you know, maybe that's a big assumption. But when you raise interest rates, there is this argument that maybe you're dampening future expansion and investment at a time when you really want to see it expand. And housing is kind of an example of that, even though a lot of construction has been stronger than people have expected. How are you sort of viewing that tension between higher rates maybe impacting capacity versus trying to reduce demand? I think it's just a time horizon question, because inflation doesn't help in building capacity either.

20:00And so if we can raise rates for a relatively short period of time, get inflation under control, and bring the economy back to the kind of economy we've had with stable prices and good employment and strong GDP. That will be good for investment. If we don't, then you've seen countries that don't control their inflation. That's a totally different investment stature. So it's one thing if you said, oh, no, wait a second, we're going to constrain the economy forever. But people who invest aren't investing based on one or two-year horizons. They're investing on long-term horizons. And I think they think us taking the moves we're taking to get inflation under control are actually helpful for investment, not the other way around.

20:37So I'm talking to lots of businesses. And one of the questions I ask them is, what's your investment posture going forward? And folks are still leaning forward on investment. We got a Durables Goods report this morning that was actually pretty healthy. Businesses are still investing. Now, that doesn't mean they're going crazy. I talked about that earlier. But they're still investing. Their investing levels are actually pretty solid. And I think that is completely just a bet on the medium to long-term perceived health of this economy. We touched on house prices, but I wanted to ask you a sort of wider question on pricing decisions that businesses are making now.

21:12I would be really curious to get your thoughts on this whole idea of sellers inflation or profit-led inflation. So we've heard some ECB members talk about it, this idea that maybe companies are using these industry-wide shocks to propagate higher prices. And we have seen a lot of shocks over the past couple of years. I think Brennerd might have mentioned this way back in January, but of course, she's not at the Fed anymore. Is the Fed thinking about this dynamic at all? I'll put a little different because I do believe in capitalism. And I do believe that companies raise price when they have an opportunity and lower price.

21:50I very carefully avoided the greedflation label. Yeah. So but here's, I think, what's going on. It's been 20 or 30 years before COVID of 2 % to 3 % inflation, very stable prices. Part of that, I hope you think, was good leadership by the Fed. But part of that was a set of elements in the economy that held businesses back. E-commerce meant that people could electronically shop prices. You go to a bookstore and you just click and compare it to Amazon. Big companies, autos being the first, but many big companies invested in big purchasing departments that allowed people to negotiate. Your big box retailers were famous for saying, don't give me any price increases or I'll take manufacture to China.

22:31You had offshore production. You had offshore labor. You had demographics. You had fracking. There's a whole set of things that kept pricing under control and frankly kept businesses away from pricing. So when the tariffs happened in 2018, I talked to a lot of businesses affected by the tariffs. I said, are you going to increase price? And they said, well, I'll increase them to this segment of my customer base, but I can't take it to one of the big home improvement chains because they won't accept it. And that's market power. And that was being deployed in an effort to keep prices under control.

23:02But businesses also didn't have the confidence to raise prices. So then you have these supply constraints, you have the stimulus, you have the inflation comes. And in every boardroom in this country, some business person put their plan together and the board said, well, why aren't you being more aggressive with price. And so those folks who had big cost squeezes or availability problems, they increased their price. And those people who colorably could explain that they might have those things also increased their price. And I don't think that's greedflation or, I mean, that's just how businesses react.

23:34And the way I think about it is after 20 years, 30 years of price not being on the table as a lever, it's now on the table as a lever. And I would say, having been a consultant in my life, it is the quickest way to make more money if you're successful. Price goes straight to the bottom line. You don't have to hire any other people. It's a very good profit lever if it works. And so businesses that got that opportunity aren't going to stop trying until either their customers or their competitors make them stop. Now, you see in many sectors, prices coming down or even going the other way, apparel, used cars being examples.

24:11So I'm not saying this is a permanent thing, but it's part of why I think inflation, once having blossomed, is somewhat slower to settle. Because I just think it takes time to get back. I'd remind you that we didn't get the Volcker inflation fighting team. I think the number is by 1986 had gotten inflation down to 4%, and it took down to the 90s to get it to 2%. It just takes a while once you've unleashed inflation to put it back in the box. This is so interesting. So let's bring wages into the picture now, right? Because it seems like there's a lot of new research emerging from various corners of the Fed system.

24:51Some Fed presidents have been talking about this idea that it looks like in the data, wages are more likely to follow prices than the other way around. Now, of course, when we think about kind of the textbook explanation of how monetary policy works, it's like you raise interest rates that loosens the labor market that puts downward pressure on wages, and then that downward pressure on wages filters through to prices. So which side of this argument do you kind of come down on? Well, I'm not a trained economist, but I kind of want to say both sides. So let me try to explain that. You can get away with it as an untrained economist.

25:24So there's no question in my mind that this bout of inflation wasn't driven by wages. It was driven by a set of other things, supply constraints and fiscal stimulus, which increased demand and that sort of thing. And so prices went up. And then a bunch of people, including I'm sure the two of you, said, huh, I wonder why my merit increase is only two and a half percent when inflation's five or six. Shouldn't I have a higher merit increase? I mean, that's how the world works. So in that part of the world, prices drove wages. And when I talk to people this year about merit increases, they'll say, well, inflation's come down, so maybe I won't give three, maybe I'll give four.